UK VAT explained: Cash vs accrual accounting

The chances are that as a growing business you will quickly encounter the UK’s Value Added Tax (VAT) system. There is a full VAT explainer here, but in brief, you must register for VAT if: 

  • you expect your VAT taxable turnover to be more than £85,000 in the next 30-day period 
  • your business had a VAT taxable turnover of more than £85,000 over the last 12 months 

You might also need to register, depending on the kinds of goods or services you sell and where you sell them. You can also register voluntarily – there is more information about that here. Whatever you decide, once you become VAT-registered then you have some decisions to make on how you account for your VAT payments and liabilities. 

Following VAT Registration  

There are two different ways in which UK businesses can run their VAT accounting. Which approach they choose will depend on a number of factors: the size of the business, its individual needs, the amount of external support it has. Whichever approach you decide to take you will need to make sure that you maintain the correct records and stay informed of any changes in the regulations.

The two VAT treatments are cash accounting and accrual basis. And, crucially, the key difference between cash basis and accrual basis accounting centres on timing.  And principally it is based on when you record a transaction – whether that’s the receipt of income or payment of tax 

If you record it when you actually receive or pay the money, then it is cash accounting; however if you record it when you raise or receive an invoice even if terms are 30 days then you are using accrual accounting.  

So which one is right for you?

Not all businesses can use cash accounting, as HMRC has limits on turnover. If your business generates a turnover of up to £150K pa then you are able to use cash accounting.  So while this method is restricted to smaller businesses, it can you’re your cashflow as you only account for VAT when you are actually paid (or you pay for purchases).  

With accrual accounting, conversely, VAT becomes payable (and claimable) as soon as you record the invoice, even if you have not been paid. For instance, if your invoices are dated March, they should be posted in the March period.  

Critically, it is the posting date that will determine in which period the invoices will actually be recorded into your accounting software. By using this method, VAT on these invoices will then be recorded in March and then reported to HMRC as VAT receivable for March. 

While this may seem like a small difference, it does have a significant effect, particularly for a larger business, since it provides a more accurate picture of the businesses finances & performance. As such, the UK accrual is the most common type of VAT accounting in the UK.  

As experts in the field, we work to help our clients to decide what’s right for them as their business grows. We’re here for whatever you need, and you can contact us for help and support in a number of areas, from tax and payroll to accounting and banking